Walker & Dunlop, Inc. — Q3 2013 Form 10-Q
Business context and period: The company originates, brokers, sells and services commercial real estate loans, primarily multifamily, through Fannie Mae, Freddie Mac, HUD/Ginnie Mae and institutional channels. This unaudited filing covers the quarter and nine months ended September 30, 2013; comparisons are with the same 2012 periods. The 2013 results include CWCapital, acquired in September 2012, which materially affects comparability.
Financial performance and position
- Q3 revenue: $73.7 million, up 5% year over year. Mortgage banking gains fell 15% to $45.3 million as originations declined, partly offset by servicing fees rising 72% to $23.0 million.
- Q3 earnings: Operating income was $12.7 million, up 8%; net income was $8.1 million, up 13%. Diluted EPS was $0.23 versus $0.28, reflecting a substantially higher weighted-average share count.
- Nine-month revenue and earnings: Revenue was $233.6 million, up 54%; operating income was $48.8 million, up 34%; net income was $30.3 million, up 36%. Diluted EPS was $0.88 versus $0.96.
- Margins: GAAP operating margin was 17% in Q3, unchanged year over year, and 21% for nine months versus 24%. Adjusted operating margin, a non-GAAP measure, was 19% versus 34% for Q3 and 22% versus 32% for nine months. Management attributes pressure to a larger share of lower-margin brokered and interim lending.
- Origination volume: Q3 volume was $1.76 billion, down 19%; nine-month volume was $6.05 billion, up 44%. Nine-month growth included acquisition effects. Q3 Fannie Mae and Freddie Mac volumes declined, while brokered originations increased.
- Cash flow: Nine-month operating cash flow was $751.1 million, compared with cash used of $902.3 million in 2012. The swing primarily reflects timing and volume of loans originated and sold; excluding those loan flows, operating cash provided was $20.9 million versus $0.7 million. Cash and equivalents declined $4.1 million from year-end to $61.0 million.
- Balance sheet and debt at September 30: Total assets were $1.068 billion and stockholders’ equity $390.5 million. Warehouse borrowings were $429.9 million and term notes payable $74.7 million. Loans held for investment were $118.9 million; management said none were delinquent and no loan-loss allowance was recorded.
- Liquidity: Operational liquidity was $69.3 million against a $16.9 million minimum requirement. The company reported compliance with applicable warehouse and term-loan covenants and expected operating cash flows to cover obligations for the next 12 months. Restricted cash was $7.0 million and pledged securities $45.4 million.
- Servicing assets: Servicing portfolio unpaid principal balance was $38.7 billion, up from $33.9 billion a year earlier. MSRs had a reported fair value of $400.0 million; a 100-basis-point increase in the discount rate would reduce estimated fair value by $13.2 million.
Material changes, outlook and risks
- Management cited rising interest rates, FHFA limits on GSE production, constrained HUD commitment authority and competition from banks and life insurers as headwinds to originations. HUD temporarily stopped approving new loans after exhausting authority in September, then received $6.25 billion of authority through December 31, 2013 following an October funding interruption. The company said effects on future volume remain uncertain.
- In October, the company implemented a cost-reduction plan eliminating 52 positions and closing an office and its small-loan program. It expected annual savings above $7 million and fourth-quarter 2013 severance and lease-termination charges of $0.8–$1.2 million.
- The company launched a large-loan bridge program in Q3, funded through a third-party partnership. No loans had been originated under the program by September 30.
- In October, management announced plans to seek $150–$200 million of senior secured term debt, potentially to repay the existing term loan and fund general corporate purposes. Completion depended on market conditions; the filing said conditions had not been favorable.
- Fannie Mae’s revised collateral rules were expected to require an additional $42 million of restricted liquidity over 48 months, assuming no portfolio paydowns, prepayments or defaults. Management said it was compliant and did not expect a material operating impact, but further collateral changes could reduce available cash.
- The Fannie Mae DUS portfolio carried a maximum quantifiable guarantee exposure of $3.6 billion; the filing cautions this is not a likely-loss estimate. The recorded risk-sharing allowance was $8.5 million. The at-risk portfolio had $9.1 million more than 60 days delinquent, or 0.06% of that portfolio.
- In the Capital Funding litigation, a jury awarded $1.75 million against defendants and $10.4 million against Credit Suisse; the claimant elected to pursue the latter judgment. The company said it had no exposure under that election and believed Column’s indemnification covered the judgment. Post-judgment motions and possible appeal remained pending.
- No formal earnings guidance was provided. Management said it did not anticipate dividends in the foreseeable future. It noted results may fluctuate with interest rates, transaction volumes and economic conditions.
Most important facts for investors to verify
- Whether GSE production limits and HUD funding availability change origination volumes, product mix and margins.
- Whether the proposed $150–$200 million term financing is completed, on what terms, and how proceeds are used.
- Realized savings and restructuring costs from the October cost-reduction plan.
- MSR valuation assumptions and sensitivity to discount rates, prepayments and servicing costs.
- Actual liquidity impact of Fannie Mae collateral requirements and any subsequent changes.
- Credit performance, loss experience and reserve adequacy for DUS risk-sharing and the growing interim-loan portfolio.
- Outcome of the Capital Funding post-judgment proceedings and enforceability of the stated indemnification coverage.